Tag Archives: Gray Financial

The latest constitutional challenge to an SEC administrative enforcement proceeding was filed in the United States District Court for the Northern District of Georgia on February 19, 2015 in a case captioned Gray Financial Group, Inc. v. SEC, No. 1:15-cv-0492 (N.D. Ga.). Gray Financial is a registered investment advisor subject to SEC regulatory oversight, and, as a result, has not been newly subjected to SEC administrative proceedings by the Dodd Frank Act’s 2010 expansion of jurisdiction of SEC administrative law judges to non-regulated persons. As a result, the theory of the case is limited to alleged constitutional shortcomings that are unaffected by whether or not the putative respondent is an SEC-regulated entity. In this respect, of the recent cases challenging SEC administrative enforcement actions, Gray Financial most resembles Stilwell v. SEC, previously filed the Southern District of New York. SeeStilwell v. SEC.

The complaint alleges that Gray Financial is a small investment advisory firm registered with the SEC, and in Georgia and Michigan. It established as an investment alternative for Georgia-based pension funds, and with advice of counsel, an “alternative investment” in the form of a fund of funds. Georgia recently adopted a new pension law permitting alternative investments by public pension funds. The SEC commenced an investigation of whether the new fund complied with the Georgia law. The SEC staff thereafter issued a “Wells notice” on the theory that the fund was not in compliance with the Georgia pension law. Gray Financial contends that the Georgia law is unclear, has never been interpreted by Georgia courts, and that it acted only on the advice of experienced counsel. Nonetheless, the SEC argued the firm intentionally violated the Georgia law and insisted on a “draconian” settlement to avoid an administrative enforcement proceeding. A copy of the complaint is available here:Gray Financial Group v. SEC Complaint.

The complaint describes the SEC administrative proceeding process and the role of SEC ALJ’s in detail, including the insulation of the ALJ’s from removal by the SEC or the President for other than good cause. It then lays out its constitutional argument that the SEC administrative law judges are executive officers outside of the control of the President, in violation of Article II of the Constitution:

Article II’s vesting authority requires that the principal and inferior officers of the Executive Branch be answerable to the President and not be separated from the President by attenuated chains of accountability. Specifically, as the Supreme Court held in Free Enterprise, Article II requires that executive officers, who exercise significant executive power, not be protected from being removed by their superiors at will, when those superiors are themselves protected from being removed by the President at will.

The SEC ALJs’ removal scheme is contrary to this constitutional requirement because SEC ALJs are inferior officers for the purposes of Article II, Section 2 of the U.S. Constitution, and because:

a. SEC ALJs are protected from removal by a statutory “good cause” standard; and

b. The SEC Commissioners who are empowered to seek removal of SEC ALJs – within the constraints of the “good cause” standard – are themselves protected from removal by an “inefficiency, neglect of duty, or malfeasance in office” standard; and

c. The MSPB members who are empowered to effectuate the removal decision – again limited by a “good cause” standard – are themselves protected from removal by an “inefficiency, neglect of duty, or malfeasance in office” standard.

Under this attenuated removal scheme, “the President cannot remove an officer who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his duties or discharging them improperly. That judgment is instead committed to another officer, who may or may not agree with the President’s determination, and whom the President cannot remove simply because that officer disagrees with him. This contravenes the President’s ‘constitutional obligation to ensure the faithful execution of the laws.’” Free Enterprise [Fund v. Pub. Co. Accounting Oversight Bd.], 130 S. Ct. at 3147 (quoting Morrison v. Olson, 487 U.S. 654, 693 (1988)).

Because the President cannot oversee SEC ALJs in accordance with Article II, SEC administrative proceedings violate the Constitution.

Although the complaint describes many respects in which SEC administrative proceedings are less fair to respondents than federal court actions, it does not explicitly contend that the SEC’s threatened administrative proceeding would violate due process, the equal protection clause, the Seventh Amendment right to a jury trial in civil actions, or be an arbitrary and capricious agency action under the Administrative Procedure Act. That likely is because SEC-regulated entities like Gray Financial have long been subject to administrative enforcement actions as part of the SEC’s overall authority over regulated entities.